I wrote a blog in December last year about how difficult personal risk insurance (e.g. income protection, Life and TPD) is becoming to obtain. In addition, in December, the government directed Australian insurers to make some very significant changes to their products. I have been waiting to measure the insurers response to these directives. These changes will have a significant impact on your future insurance options.
What is currently offered
Before I discuss the changes that the government has asked for, it’s important to appreciate the status quo. Most income protection policies have four main variables:
1. Benefit amount
This is the amount of income you are insured for. Most insurers allow you to insure up to 75% of your current gross income (not 100%, otherwise there’s little financial incentive to return to work). Benefit amounts are typically expressed as a monthly amount. The monthly benefit is taxed at your marginal tax rates – so a $10,000 benefit will result in an income of circa $7,140 per month after tax.
2. Waiting period
This is the period of time you must be incapacitated for before you are able to claim a benefit from the insurer. Typically, the options include 30 days, 60 days, 90 days, 6 months or 2 years. Often, the most economical wait period is 90 days. Benefits are paid one month in arrears. So, a 90 day wait period means you won’t receive any income for 4 months.
3. Agreed or indemnity
If a policy is agreed value, it means that if you become fully incapacitated, you will receive the benefit irrespective of the level of your income prior to you becoming incapacitated. Therefore, someone could have an agreed value policy for $10,000, subsequently become unemployed and then have an accident and they will be paid the full benefit.
Alternatively, an indemnity policy requires the insurer to measure your level of income in the period prior to you becoming incapacitated and pay the lesser of up to 75% of that amount or your insured benefit. This means, if your income was nil, you would not receive a benefit, despite paying the premiums for insurance cover (I elaborate on this further below).
4. Benefit period
The benefit period is how long you will receive a benefit for whilst you are still fully or partially incapacitated. Given we want protection against long term incapacity, we typically advise clients to obtain a benefit period to age 65. This means if you become incapacitated, the insurer will keep paying you until you attain age 65.
This blog discusses income protection insurance in more detail.
Why has the government stepped in?
According to the Australian Prudential Regulatory Authority (APRA), over the past 5 years, Australian insurance companies have lost $3.4 billion in respect to income protection policies. In the 9 months to September 2019, they lost $1 billion alone. This means that insurers paid out a lot more money in benefits (to insured persons) than they received in premiums (and investment returns).
APRA is worried that insurers may start withdrawing from the Australian market. If they did, income protection insurance would no longer be available, which would be to the detriment of Australians. However, none of the insurance companies have been brave enough to be the first one to make changes to their products or pricing (to make them more sustainable) – for fear of losing too much business. So, the government has stepped in and forced the changes upon the whole industry.
APRA has request two main changes be made. These are discussed below.
Key change # 1: you may not receive the benefit you have insured
APRA wants all insurers to cease offering agreed value income protection policies from 31 March 2020. In addition, they want insurers to ensure your total income (which could include compensation payments, annual leave, sick leave, etc.) does not exceed 100% of your pre-disability income in the first 6 months of a claim. This means if you receive other income, it may reduce your insurance benefit (possibly to nil).
Key change # 2: Maximum 5 year contract terms and tighter rules for long term benefits
APRA wants insurers to reduce contract terms to no more than 5 years. Currently, contract terms can be very long (e.g. until you are aged 65). This means insures cannot change the terms of coverage over this period. However, APRA wants contracts to be renewed every 5 years (without requiring medical underwriting). For example, you may have a great quality policy today but in 5 years’ time, the insurer might reduce the comprehensiveness (and therefore quality) of the cover. This gives you two options (1) accept the lower quality product or (2) move to a different insurance company (with the requirement of medical underwriting).
Also, APRA wants to make it more difficult to continue to receive a long-term benefit (e.g. have stricter disability definitions for long benefit periods).
Problems with indemnity value policies
As discussed above, indemnity value policies require the insurer to determine your pre-disability income at the time of claim. Most insurance companies will measure this as the best consecutive 12 months period over a period of between 2 and 3 years prior to becoming incapacitated.
Therefore, if your income reduces after you have established your income protection policy, it is possible that you are paying an insurance premium for a benefit that you will never fully receive. This will more likely impact people that can experience variability in income such as contractors and people that are self-employed. Employees that have a career change could also be affected.
Of course, if your income does permanently reduce after you have established an insurance policy, you could reduce the benefit amount to minimise the premium cost. However, the risk of doing this is that if you want to increase the benefit again in the future, you will be subject to full medical underwriting (testing). If you are in perfect health, this might not be much of a concern. However, perfect health in an insurer’s eyes can be different to ours – which I’ve explained here. As such, you might find it difficult (impossible) to increase the benefit at a later stage.
Can you lock-in a higher agreed value benefit prior to 31 March 2020?
No. Insurers are not offering agreed value contracts to existing customers. If you apply to increase your benefit on an existing policy, you will be offered indemnity value only. That said, most insurers are still offering agreed value on new policies until 31 March 2020.
Cover insider super is unaffected
Income protection cover inside your super fund has always been indemnity value (no agreed value was ever available). It had to be indemnity value in order to comply with the super release rules. Therefore, the changes discussed above only affect policies held in your personal name. As I have explained further in this blog, income protection insurance inside super often does not provide an adequate level of cover.
What action should you take as a result of this change?
If you don’t have any income protection insurance and need it, you should arrange it now whilst agreed value policies are still available.
If you have existing income protection insurance cover and you want to cancel the cover or switch providers, be very careful with this decision. It is likely that you will never get a replacement policy that is agreed value, and this might expose you to higher risk.
Do you need our advice?
If you would like us to review your insurance cover, we would be happy to do so, as part of our holistic financial advisory service. To find out more above this, simply email Kristy Dishon directly.